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OpenTable's losing money, but it just sold for $2.6 billion

Priceline announced today that it is buying the restaurant reservation service OpenTable for $2.6 billion in cash, representing a 46% premium over OpenTable's closing price in the stock market on Thursday. That's a large premium and it represents a very aggressive valuation of a company that lost $3.6 million on $53 million in revenue in the first quarter of this year. The cash part is important, too. Priceline's stock has soared this year. Sometimes when that happens, executives privately think their own company has become overvalued and express that by making stock-financed acquisitions. But Priceline is paying real money here.

But beyond the money, the basic strategy for Priceline here is clear. Over the past several years they've acquired a bunch of other travel companies, and now are looking for new growth horizons. Restaurant reservations are a logical adjacent market to Priceline's core competency in hotel and airline bookings (indeed, on my phone my OpenTable app is in my Travel folder).

Whether this will pay off or not probably depends on whether or not you think there are important network effects in the restaurant booking sector.

In an industry with network effects, people want to use a product in part because other people are already using the product. That would be a world in which customers try to decide where to dine by firing up OpenTable, meaning that restaurants feel they need to be on OpenTable or else they'll be invisible. And since OpenTable is where all the restaurants are, that's where all the diners look. That's a virtuous circle that shields OpenTable from competition and lets them extract some surplus from the basic transaction.

But another view is that people will simply seek out specific restaurants, and then book online through whichever service the restaurant is affiliated with.

That's a world in which competition between rival booking services (OpenTable's main rival right now seems to be CityEats) will make it really hard to accumulate big profits. Indeed, one can easily imagine the sector devolving to a situation in which no profits are made off handling the booking and a company (Google or Amazon, say) performs this service at cost for the sake of acquiring the user data.